The government has filed its brief opposing certiorari in Historic Boardwalk. The government characterizes the decision as resting “on a fact-bound examination of the agreements between the parties” that presents no legal issue of broad applicability warranting Supreme Court review. The brief responds at length to the taxpayer’s argument that the court of appeals misapplied Commissioner v. Culbertson, 337 U.S. 733 (1949), maintaining instead that “the court of appeals properly applied the framework set forth in Culbertson.”

As we previously noted, the taxpayer faces an uphill battle because the Court rarely hears technical tax cases over the government’s opposition in the absence of a circuit conflict. The Court is expected to act on the petition on May 28.

[Note: Miller & Chevalier filed an amicus brief in the Third Circuit in this case on behalf of National Trust for Historic Preservation]

We have previously reported extensively (see previous reports here) on the Third Circuit’s decision in Historic Boardwalk denying a claim for historic rehabilitation tax credits by the private partner in a public/private partnership that rehabilitated a historic property on the Atlantic City boardwalk. Although the Third Circuit declined to rehear the case, the taxpayer has now filed a petition for certiorari seeking Supreme Court review (docketed as No. 12-901).

With no conflict in the circuits on the issue presented, the petition argues that Supreme Court review is needed because of the issue is new and has potentially broad ramifications, stating: “This is the first litigated case in the country where the Internal Revenue Service has made a broad based challenge to the allocation of Congressionally-sanctioned federal historic rehabilitation tax credits by a partnership to a partner.”

The petition elaborates by proffering three reasons why the case should be viewed as presenting tax law issues of exceptional national importance. First, the Third Circuit’s ruling that the taxpayer was not a bona fide partner is asserted to squarely conflict with Commissioner v. Culbertson, 337 U.S. 733 (1949). Second, the petition criticizes the court of appeals’ holding that the allocation of tax credits “should be considered a ‘sale’ or ‘repayment’ of ‘property’” as “utterly baseless” and at odds with Supreme Court precedent. Third, the petition criticizes the Third Circuit for considering the credits themselves as a component of the substance over form analysis.

The petition urges the Court to hear the case because of its importance, stating that it undermines Congress’s intent “to encourage private investment in the restoration of historic properties” and that the issues “bear broadly on . . . thousands of [historic rehabilitation tax credit] partnership investment transactions across the nation involving billions of dollars.” The breadth of the impact of a decision is an important factor in the Court’s consideration of whether to grant review, but the petition still faces an uphill battle, as the Court rarely grants certiorari in technical tax cases in the absence of a circuit conflict – unless the government urges it to do so. Here, there is every reason to expect that the government will oppose the petition.

The government’s brief in response is currently due, after one 30-day extension, on March 25.

The Third Circuit yesterday denied the taxpayer’s petition for rehearing en banc in Historic Boardwalk in what seems like record time (the petition was filed on October 10). The taxpayer’s last hope is to seek Supreme Court review, though the case does not look like one that could pique the Court’s interest. A petition for certiorari would be due on January 22.

The taxpayer has filed a petition for rehearing and rehearing en banc in Historic Boardwalk, asking the Third Circuit to reconsider its decision denying the taxpayer’s claim for historic rehabilitation credits. Among other points, the petition criticizes the panel’s decision for analogizing this case to the Second Circuit’s Castle Harbour decision, TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006), which found that the partner there had no downside risk that it would not recover its capital contribution. The taxpayer argues that there was a risk here that the partner would not recover its capital contribution from the partnership, and the court erred in finding that there was no risk by taking the tax credits into account. Specifically, the petition argues, “the Opinion wrongfully treats the allocation of the historic rehabilitation tax credits to [the investor] by operation of law (i.e., under the Code) as a repayment of capital to” the investor by the partnership.

There is no due date for a response by the government. Under Rules 35 and 40 of the Federal Rules of Appellate Procedure, a party is prohibited from responding to a petition for rehearing unless it is directed to do so by the court.

[Note: Miller & Chevalier filed a brief in this case on behalf of National Trust for Historic Preservation]

In a detailed 85-page opinion, the Third Circuit has reversed the Tax Court’s opinion that upheld a claim for historic rehabilitation tax credits by the private partner in a public/private partnership that rehabilitated a historic property on the Atlantic City boardwalk. See our earlier report here. The government had argued both that the transaction lacked economic substance and that the private partner, Pitney Bowes, was not a bona fide partner in the enterprise. The Third Circuit agreed with the government’s second argument and therefore found it unnecessary to decide whether there was economic substance. Given that approach, the court stated that it would “not opine on the parties’ dispute” on whether the Ninth Circuit was correct in Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995), in stating that the policy of providing a rehabilitation credit as a tax incentive is relevant “in evaluating whether a transaction has economic substance.” Slip op. 54 n.50. The court did make some general observations on economic substance, however, noting its agreement with amicus that the government’s position had inappropriately blurred the line between economic substance and the substance-over-form doctrine, which are “distinct” doctrines. Slip op. 52 n.50. Citing Southgate Master Fund, L.L.C. v. United States, 659 F.3d 466, 484 (5th Cir. 2011), the court added that “even if a transaction has economic substance, the tax treatment of those engaged in the transaction is still subject to a substance-over-form inquiry to determine whether a party was a bona fide partner in the business engaged in the transaction.” Slip op. 53 n.50.

Turning to the issue that it found dispositive, the court concluded that Pitney Bowes was not a bona fide partner because it “lacked a meaningful stake in either the success or failure of [the partnership].” Slip op. 85. In reaching that conclusion, the court relied heavily on two recent court of appeals’ decisions, the Second Circuit’s analysis of bona fide equity partnership participation in TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006) (“Castle Harbour”) and the Fourth Circuit’s analysis of “disguised sales” in Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011). Although the taxpayer had objected that the latter case was irrelevant because no disguised sale issue was present, the court agreed with the government’s argument in its reply brief that “the disguised-sale analysis in that case ‘touches on the same risk-reward analysis that lies at the heart of the bona fide-partner determination.’” Slip op. 67 n.54 (quoting U.S. Reply Br. 9). See our previous report here. The court elaborated on this point as follows: “Although we are not suggesting that a disguised-sale determination and a bona fide-partner inquiry are interchangeable, the analysis pertinent to each look to whether the putative partner is subject to meaningful risks of partnership operations before that partner receives the benefits which may flow from that enterprise.” Id. at 69 n.54.

The taxpayer had relied heavily on the Tax Court’s findings regarding the essentially factbound question of bona fide partnership, but the Third Circuit found that the deferential standard of review of factual findings was not an obstacle to reversal. The court first stated that “the record belies” the Tax Court’s conclusion that Pitney Bowes faced a risk that the rehabilitation would not be completed. Id. at 73. To deal with the standard of review, the court of appeals drew a hair-splitting distinction between the factual issue of “the existence of a risk” and what the court believed to be a “purely . . . legal question of how the parties agreed to divide that risk,” which “depends on the . . . documents and hence is a question of law.” Id. at 73 n.57. The court of appeals directly rejected other Tax Court findings regarding risk as “clearly erroneous.” Id. at 76.

The court did not dwell on the policy implications of its decision. It stated that it was “mindful of Congress’s goal of encouraging rehabilitation of historic buildings” and had not ignored the concerns expressed by the amici that a ruling for the government could “jeopardize the viability of future historic rehabilitation projects.” Id. at 84. But the court brushed aside those concerns, taking comfort in the response of the government’s reply brief that “[i]t is the prohibited sale of tax credits, not the tax credit provision itself, that the IRS has challenged.” Id. at 85. Be that as it may, decisions like this are likely to diminish the practical effectiveness of the credit as an incentive and thus to frustrate to some extent Congress’s desire to encourage historic rehabilitation projects.

The Third Circuit has scheduled oral argument in the Historic Boardwalk case for June 25 in Philadelphia. (The argument previously had been tentatively scheduled for April, but was postponed.) The panel will consist of Judges Sloviter, Chagares, and Jordan.

[Note: Miller and Chevalier represents amicus National Trust for Historic Preservation in this case]

The government has filed its reply brief in the Historic Boardwalk case in the Third Circuit. (See our prior report and the other briefs here.) The brief mostly goes over the same ground as the opening brief in seeking to deny section 47 historic rehabilitation credits to the private investor partner in the partnership that rehabilitated East Hall on the Atlantic City boardwalk. It attempts to side-step the Ninth Circuit’s economic substance analysis in Sacks by arguing that the Third Circuit did not explicitly endorse Sacks when it distinguished that case in other decisions. The brief urges the court instead to follow the Fourth Circuit’s Virginia Historic decision (see our coverage here), even though that case involved the disguised sale provisions, arguing that the case “touches on the same risk-reward analysis that lies at the heart of the bona-fide partner determination.” The government also argues that Congress’s intent in passing section 47 would not be thwarted because the private investor allegedly “made no investment in the Hall.”

Indeed, the reply brief includes a special “postscript” “in response to the amicus brief” filed for the National Trust for Historic Preservation that seeks to deflect the charge that the government’s position would undermine Congress’s purpose to facilitate historic rehabilitation. Not so, says the government. It is only “the prohibited sale of federal tax credits — not the rehabilitation tax credit provision itself — that is under attack here.”

Oral argument in the case has been tentatively scheduled for April 20.

[Note: Miller and Chevalier represents amicus National Trust for Historic Preservation in this case]

We present here a guest post by our colleague David Blair who has considerable experience in this area and authored the amicus brief in this case on behalf of the National Trust for Historic Preservation.

The government has appealed to the Third Circuit its loss before the Tax Court in Historic Boardwalk Hall, LLC v. Comm’r, which involves a public/private partnership that earned historic rehabilitation tax credits under Code section 47. The partnership rehabilitated East Hall, which is located on the boardwalk in Atlantic City. East Hall was completed in 1929, hosted the Miss America Pageant for many years, and is listed on the National Register of Historic Places. The IRS sought to prevent the private partner, Pitney Bowes, from claiming the historic rehabilitation tax credits, but the Tax Court upheld the taxpayer’s position after a four-day trial.

In its opening brief, the government advances the same three arguments in support of its disallowance that it made in the Tax Court. First, it asserts that Pitney Bowes was not in substance a partner because it did not have a meaningful stake in the partnership under the Culbertson-Tower line of cases. Second, it argues that the partnership was a sham for tax purposes under sham partnership and economic substance cases. Third, it argues that the partnership did not own the historic building for tax purposes and thus was not eligible for the section 47 credits for rehabilitating the building. In making the first two arguments, the government relies heavily on its recent victory in Virginia Historic Tax Credit Fund 2001 LP v. Comm’r, where the Fourth Circuit overturned the Tax Court and found a disguised sale of state tax credits. (See our previous reports on that case here.) Similarly, the government’s brief places heavy reliance on its first-round victory before the Second Circuit in TIFD III-E, Inc. v. Comm’r (Castle Harbor), which is now back up on appeal. (See our previous reports on that case here.) In support of its sham partnership theory, the government cites provisions in the partnership agreement that protect investors from unnecessary risks, including environmental risks. On the third argument, the government asserts that the partnership never owned the building for tax purposes because the benefits and burdens of ownership never transferred.

Having won at trial, the taxpayer’s brief emphasizes the Tax Court’s factual findings in its favor. It also emphasizes the historic character of the building and the Congressional policy of using the tax laws to encourage private investment to preserve this type of historic structure. The taxpayer argues that the partnership was bona fide because the partners joined together with a business purpose of rehabilitating East Hall and earning profits going forward. The taxpayer also argues that the partnership has economic substance. In this regard, the taxpayer argues that the Ninth Circuit’s decision in Sacks v. Comm’r, 69 F.3d 982 (9th Cir. 1995), requires a modification of the normal economic substance analysis where Congress has offered tax credits to change taxpayers’ incentives. The taxpayer also argues that the partnership owned East Hall for tax purposes and therefore was eligible for the section 47 credits.

The National Trust for Historic Preservation filed an amicus brief in support of the taxpayer. That brief sets out the longstanding Congressional policy of offering the section 47 credit to encourage taxpayers to invest in historic rehabilitation projects that would not otherwise make economic sense. It further explains that historic rehabilitation projects typically involve partnerships between developers and investors that are motivated in part by the availability of the credit. It also is typical for these partnership agreements to protect the investors from unnecessarily taking on business risks. The amicus brief argues that, in applying the economic substance doctrine, courts should not override the narrowly focused Congressional policy of encouraging rehabilitation projects through the section 47 credit. Thus, courts should not simply review the non-tax business purpose and pre-tax profitability of investments in historic rehabilitation projects, but should acknowledge that the taxpayer can properly take into account the credits that Congress provides for historic rehabilitation projects. To do otherwise, as the Ninth Circuit observed in Sacks, “takes away with the executive hand what [the government] gives with the legislative.” The amicus argues that, at any rate, the transaction met the economic substance doctrine under Third Circuit precedent and that the partnership and Pitney Bowes interests were bona fide. It also points out that the Virginia Historic case is inapplicable because it involved a disguised sale, which the government has not alleged in this case. Similarly, the Castle Harbor case is distinguished on its facts due to the differences in the partnership agreements in the two cases.

The Real Estate Roundtable also filed an amicus brief, which highlights to the court that the recent codification of the economic substance doctrine in Code section 7701(o) places significant pressure on the distinction between, on the one hand, the economic substance doctrine, and on the other hand, substance-over-form and other “soft doctrine” attacks on transactions. This is due to the strict liability penalty that can apply to transactions that violate the economic substance doctrine. As the IRS has recognized in recent guidance under section 7701(o), it is necessary for the IRS and courts to carefully distinguish between cases where the economic substance doctrine is “relevant” and those where other judicial doctrines apply. The Real Estate Round Table then argues that the transaction at issue had economic substance.

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.